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By Conor Molumby (Bloomberg) — All hail fuel oil, historically the cheapest, dirtiest and least-loved thing to come out of refineries. Thank crude output cuts by OPEC and its allies for the surprise ascendance of the product used to power ships and generate electricity.
1. OPEC Hits Supply of Fuel Oil-Rich Crudes
OPEC’s influence on the oil market is perhaps most apparent in the market for types of crude that yield a lot of the fuel oil, normally the cheapest thing refineries make. The price difference has collapsed between high-quality North Sea crude, popular for making products like gasoline, and key Middle East grades that churn out more fuel oil in the refining process. The so-called crack spread for fuel oil, a measure of refining profit, has surged to the highest for the time of the year since at least 2010 in the U.S., according to fair-value data compiled by Bloomberg.
2. OPEC, Russia Cut Crude Supplies
The Organization of Petroleum Exporting Countries pumps mostly heavy, sour crude, meaning its production cuts are hitting that corner of the market disproportionately. That in turn restricts supplies of fuel oil-rich feed-stock. Russia, which is participating in the curbs, will export 6.8 percent less of its key Urals crude this month than a year ago. The grade yields more fuel oil than many other crudes.
3. U.S. Fuel Oil Stockpiles Are Draining, Flows Dipping
Fuel oil inventories are beginning to diminish in the U.S., where physical prices for medium and heavy sour crudes in particular are showing signs of strength. Key exporter Russia has for years worked toward reduced fuel oil exports and is at last successfully restricting those outflows. The nation shipped an average of 3.5 million tons a month this year, down from in 4.8 million a month in the same period in 2015. Widespread curbs to refinery processing rates in Latin America, another big source of supply, has further boosted fuel oil, according to Energy Aspects Ltd., a London-based consultant.
4. They Don’t Make Refineries Like They Used to
They make them better. That means the plants produce less fuel oil and more high-value stuff like gasoline, diesel, jet fuel and products to make petrochemicals. That shift has also restricted supply of fuel oil, particularly in the Middle East and Asia, where Energy Aspects says demand is strengthening. While U.S. shale suppliers are continuing to contribute to a flood of crudes that are good for making these high-margin products, they don’t help so much when it comes to fuel oil.
5. There’s a Giant, Sulfurous Cloud on the Horizon
It’s not all plain sailing. In 2 1/2 years, everything changes in the fuel oil market. From 2020, ships will have to restrict the amount of sulfur they emit, down to 0.5 percent, from 3.5 percent at the moment. Demand for the product as it’s currently made can only be maintained if the merchant fleet fits equipment to remove it. That seems unlikely. “Fuel oil demand will drop significantly in 2020,” said Ehsan Ul-Haq of Economist Resource Ltd.
© 2017 Bloomberg L.P
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